FAU FIN 3403 Bond Valuation (Proctor) - BONDS and BOND...

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BONDS and BOND VALUATION Bonds-Coupon Bonds are simply loans from a government or corporation to a lender or buyer of the bond (individuals, mutual funds, governments, etc) in which the issuer sells the bond and in return for receiving the price of the bond they pay to the buyer an annual or semiannual coupon interest payment until maturity and at maturity they pay back the Par or Face Value, which is typically $1,000.Interest Rates or YieldsBasis Point:1/100 of 1% of interest, i.e., One percentage point = 100 Basis pointsPrices:There are conventions in bond pricing quotes because people and publications do not wish to print all digits of a price when they can base it on a par of $100 and have the same meaning except we are all supposed to know that the par is really $1000. Therefore:1 point in price = $1 on $100 par value, but Par values are typically $1000.So, if the price = $90 $900 on a $1000 FV bondTreasury Securities(Bonds & Notes)Notes have a maturity of 1 yr 10 yrs, Bonds have a maturity of 10 yrs 30 yrs. This next point pertains only to Treasuries. Each point in price is divided into 32nd’s or 64th’s which are multiples of 8ths. This is no different than feet being 12 inches, etc, just a way of breaking a unit into parts.This implies that a quote in the WSJ of 90:05 means 90 and five 32nds, so 90:05=90 5/32 = 90.156 on $100 of Par, but $901.56 on $1000 Par. Likewise, 85:31 = 85 31/32 = $859.69 on 1000 Par. So, prices proceed as follows: 89:31, 90:00, 90:01, 90:02, 90:03…90:29, 90:30, 90:31, 91:00, etc.A Typical Bond QuoteRateMaturityMo/YrBidAskedChgAskedYield1 5/8 Feb 06 n99:3099:31+13.22 1 1/2 Mar 06 n99:2299:23+14.18 2 1/4 Apr 06 n99:1799:18....4.48 2 May 06 n99:1399:14+14.45 4 5/8 May 06 n100:00100:01....4.43 1
6 7/8 May 06 n100:16100:17-14.38 2 1/2 May 06 n99:1399:14+14.51 2 3/4 Jun 06 n99:1199:12+14.5Corporate Bonds: Prices are quoted in fractions of a point in 1000th’s of a pointeg. 98.203, 105.685, etc. and are based on a par of 1000, so these would be priced at $982.03 and $1056.85.Bonds Features1)Coupon Rate– the annual, or almost universally, semiannual interest payment from the issuer of the Bond. The coupon rate quoted as a percent of par or face value, i.e., 5% of $1000 is $50 per year and if paid semiannually would be two $25 payments per year, every 6 months.2)Par or Face Value– the value that is repaid at the maturity date, usually $1000 but this can vary for different bonds, i.e., some municipal bonds have face values of $25000. 3)Maturity– the length of time that the bond is outstanding, i.e., the length of time of the loan.4)Yield to Maturity– the discount rate which equates the present values of all net cash flows to the cost or price of the bond.5)Price or Present Value of a BondNote that the bond price consists of a Present Value of an Annuity and the PV of a lump sum.Therefore, for a constant annualcoupon bondwe have:)nyrsr%,FV(PVIF)nyrsr%,FACoupon(PVIPriceIn terms of the pricing equation, we have:NYTM)(ParNttYTM)(tCouponNttYTM)(tCashFlowtice11111PrN-NYTMParYTMYTM- Coupon )1(11

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